The Carry and Value Pendulum

Alternative risk premia portfolios, which typically employ strategies such as carry, value and momentum across asset classes, are growing
increasingly popular as investors look to enhance returns and diversification. Here, we focus on carry and value in particular and propose that,
rather than treat them as distinct factors, investors should consider them as connected subcomponents of an asset’s total expected return.

Disclosures

1Early academic evidence of the failure of the uncovered interest rate parity in currencies, and the existence of carry returns was presented in Meese, R.A., and Rogoff, K, 1983, “Empirical Exchange Rate Models of the Seventies: Do they fit out of sample? Journal of International Economics 14, 3–242For example, most famously, Fama, Eugene F., and Kenneth R. French, 1992, “The Cross-Section of Expected Stock Returns,” The Journal of Finance 47, 427-465.3This reversion speed corresponds roughly to a half-life of three years. If we use the full data set to estimate empirically the reversion speeds, we get roughly 30% per year in both cases, corresponding to a half-life of approximately 2 years.4We could also use the PPP value as a simple, and often cited, value metric. Interestingly, the PPP metric can be flawed for certain currencies that are strongly driven by other factors such as exports. An example would be Norway, whose currency is largely affected by oil prices, for which the PPP model shows little mean-reverting behavior over the 2000-2014 period. This is a potential pitfall of our a naïve expected return approach, since an asset that can drift very far from fair value for long periods in a unit-root form will then generate unrealistically large value-convergence returns that will dominate the carry component completely.5The first five years of our dataset required us to calculate the initial five-year averages of spot rates used as value metrics.6In our examples we define one unit as follows: For swaps, long one unit is equivalent to receiving fixed on a 10-year interest rate swap with a duration of 10 years. For currencies, one unit is 100% notional invested in foreign currencies versus the USD. This scaling choice is largely arbitrary since these portfolios are long/short and unfunded.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond
market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond
strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those
with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current
reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or
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be suitable for all investors. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Derivatives
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Expected return is an estimate of what investments may earn on average over the long term and is not a prediction or a projection of future results. Actual
returns may be higher or lower than those shown and may vary substantially over shorter time periods. There is no guarantee that these returns can be
realized. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor
should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment
professional prior to making an investment decision.

Hypothetical examples are for illustrative purposes only. No representation is being made that any account, product, or strategy will or is likely to
achieve profits, losses, or results similar to those shown. Hypothetical or simulated performance results have several inherent limitations. Unlike an
actual performance record, simulated results do not represent actual performance and are generally prepared with the benefit of hindsight. There are
frequently sharp differences between simulated performance results and the actual results subsequently achieved by any particular account, product or
strategy. In addition, since trades have not actually been executed, simulated results cannot account for the impact of certain market risks such as lack
of liquidity. There are numerous other factors related to the markets in general or the implementation of any specific investment strategy, which cannot be
fully accounted for in the preparation of simulated results and all of which can adversely affect actual results.

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